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Financing the State of Victoria without Taxes
Financing the State of Victoria without Taxes A Submission by Prosper Australia to the Inquiry into State Government Taxation and Debt October 2, 2009 Introduction and Summary IF some retirees can live on income from assets instead of burdening the taxpayer, why shouldn’t the Victorian Government do the same? If the Government’s taxing power were a tradeable asset, it would have the same market value as any other asset portfolio yielding enough income to replace State taxes. If power to avoid the same taxes were an asset portfolio, it would have the same value. Hence the Government, in exchange for tax exemptions alone, should be able to acquire enough assets to replace the forgone taxes. As the asset “sellers” would avoid not only taxes but also the associated compliance costs and deadweight costs (opportunities lost because of tax implications), the tax exemptions would fairly exchange for more than enough assets (or shares of assets) to replace the forgone taxes. In each exchange, the saving in deadweight costs would be a net beneﬁt that could be shared between the State and the taxpayer, making the exchange mutually beneﬁcial. Such exchanges can be voluntary; they will be freely entered into if the law merely permits them. For politicians, the best tax reform is an optional reform: “If you don’t like the new system, you don’t have to vote against it, because you won’t have to be in it.” Opponents of an optional reform must explain why they want to impose the status quo and deprive the people of choice. If the State requires partial equity in assets in return for any tax exemptions, only current owners will be able to opt out of the tax system. If, instead, the State seeks partial tenancies (or use-rights), which are “paid out” by the other party in lieu of taxes, then the “other party” can be an owner or a tenant or sub-tenant, so that all taxpayers can opt out. Accordingly we suggest that the State Revenue Ofﬁce (SRO) be authorized to make a contract with any entity, whereby the entity shall no longer pay State taxes provided that it grants to the State • a negotiated fraction of the tenancy in each assessable asset that the entity occupies, plus • a standard fraction of the tenancy in each assessable asset that the entity subsequently occupies, where • an “assessable” asset is one that private entities cannot create or eliminate or remove from Vic- torian jurisdiction (the most obvious example being a site—i.e. a piece of ground or airspace, including attached building rights but excluding actual buildings), and • the entity shall be deemed to occupy any asset that it has a legal right to occupy or use and does not let or sublet (e.g., the owner of a vacant and unrented site shall be deemed to occupy it). This reform is superior to “increased State Government taxation” not only because shared tenan- cies would eliminate deadweight, but also because desirable infrastructure would pay for itself by expanding the revenue base without changes in rates or thresholds. Site-value rating, which already closely approximates a shared-equity or shared-tenancy scheme, should be mandated at the municipal level. 1 2 Prosper Australia Contents 1 The requirement of “no losers” 3 2 Requirements related to the Terms of Reference 3 2.1 Property development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.2 Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.3 Competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.4 Sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.5 Job security, job creation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.6 Small businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.7 Notes on “land tax” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.8 Notes on affordability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.9 Notes on municipal rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.10 Notes on debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 3 Constitutional threats to existing taxes 10 4 Rent in lieu of tax 11 5 Protecting the revenue 11 6 Deﬁnitions and explanatory notes 12 6.1 What is an “entity”? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.2 What are “taxes”? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.3 Why retain per-unit user charges? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.4 Who is deemed to “pay” a tax? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.5 What is an “assessable asset”? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 6.6 What is the “standard” fraction? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 7 Positive effect on asset values 15 7.1 All taxes come from gross economic rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 7.2 All deadweight costs come from gross economic rent. . . . . . . . . . . . . . . . . . . . . . . . . 16 8 Speciﬁc implementation issues 16 8.1 Coexistence with the tax system . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 8.2 Householders, charities, etc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 8.3 Severance “taxes”, resource rent taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 8.4 Assessing the rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 8.5 Tax base “competition” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 8.6 Additional taxes for times of emergency? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 9 Advantages for particular interest groups 18 9.1 Accountants, tax lawyers, realtors, conveyancers . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 9.2 Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 9.3 States, nations; “historical inevitability” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 10 Recessions and ﬁnancial crises 18 10.1 Prevention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 10.2 Recovery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 11 Conclusion 19 Financing the State of Victoria without Taxes 3 1 The requirement of “no losers” If it appears that a proposed tax reform would involve winners and losers, those who expect to be losers campaign against the reform and its supporters by claiming that others would be losers. The stridency of such claims is inversely related to their accuracy—why bother campaigning against an impost that you can simply shift onto someone else? Fortunately, tax reform with no losers is not a contradiction. Obviously if a reform is conducive to economic efﬁciency, the gains of the winners will outweigh the losses of any losers, so that the winners would be able to compensate the losers and still have some winnings left over. But there are at least three methods of reform that are intrinsically free of losers, so that the question of compensation does not arise. The ﬁrst, and the main subject this submission, is to make participation in the reform optional, so that those who think they would be worse off in the new system can simply stay in the old one. Having a choice that one did not have before does not of itself make one a loser. The second, which can be characterized as the ultimate extension of grandfathering, is to apply the new rules only to new entities, e.g. businesses that start up after the new rules are enacted. Entities created under the new rules cannot be worse off than before, because there is no “before”. This method can be combined with the ﬁrst; that is, older entities can be given the option of adopting the rules for new entities. The third is to deﬁne the reform in incremental terms—that is, to deﬁne changes in tax liabilities in terms of voluntary changes in taxpayers’ behaviour since the announcement of the reform, so that taxpayers who “do nothing” pay as if the legislators had done nothing. To deal with entities created after the announcement, this method needs to be combined with the second.1 As the Terms of Reference raise the twin spectres of increased taxation and increased debt, we note that it is also possible to have increased revenue with no losers. Indeed this is the usual result of economic growth under a static tax system: growth makes a bigger “cake”, so that both the government and the private sector receive bigger “slices”. But this desirable process can be accelerated (or, as the case may be, restarted!) by appropriately reforming the revenue base. This can be done in two ways: • If the reform induces the private sector to increase productive activity but still captures some consequence of that activity in the revenue net, the public and private sectors share the beneﬁts. • If the reform causes certain types of public expenditure to pay for themselves by expanding the revenue base, then the public sector gets to spend more money while the private sector retains the “after-tax” part of the increase in the revenue base. The reform suggested in this submission would involve both mechanisms. The expenditures that would “pay for themselves” would be on infrastructure, including public transport. 2 Requirements related to the Terms of Reference To eliminate any possible overlap between topics, let us paraphrase the Terms of Reference as follows: Effects of increased (i) land tax, (ii) payroll tax, (iii) conveyancing stamp duty, (iv) de- velopment levies, (v) other State taxes, (vi) other State charges, and (vii) State debt, on Victorian 1 Cf. G. R. Putland, “Employment tax credits: the ‘marginal’ approach to full employment”, On Line Opinion, Mar. 23, 2009; www.onlineopinion.com.au/view.asp?article=8685 . 4 Prosper Australia (a) development, (b) competitiveness, (c) sustainability, (d) job security, (e) job creation, and (f) small businesses. The following subheadings are guided by those in the Terms of Reference, with a few subdivisions and additions. 2.1 Property development In so far as “development” means inﬁll or greenﬁeld property development, it is encouraged by hold- ing charges on sites. Such a charge presses the owner of a vacant or underdeveloped site to develop or redevelop the site, in order to generate income to cover the charge, or sell the site to someone who will. If the holding charge is apportioned to the value of the site, the pressure to develop is higher for more valuable sites, which are more valuable precisely because they are more ripe for development. The value of the site includes the value of associated airspace and building rights, but not actual build- ings. If the incentive to develop is to be maximized, the base of the holding charge must not include values of buildings or other improvements on the site; that is, the charge must not penalize actual development. State “land tax” and municipal rates levied on site value (SV) meet these requirements, as does any other arrangement whereby the State has partial interests in site values and charges rent thereon. Municipal rates on the capital-improved value (CIV) or net annual value (NAV) do not meet the requirements. All other existing State taxes are hostile to this sort of “development”. In particular, payroll tax increases the cost of necessary labour, while conveyancing stamp duty inhibits the transactions that are needed to bring sites into the hands of developers, redevelopers and ﬁnal users. 2.2 Infrastructure In so far as “development” means public investment in infrastructure, it is encouraged by taxes or charges that recover some of the uplifts in site values caused by the infrastructure. According to the market, the beneﬁt of an infrastructure project is worth whatever people decide to pay for it. But what they pay has two components: (i) the charges for actual use of the service provided (fares, tolls, fees, etc.) and (ii) the price of access to locations where the service is available, as opposed to locations where it is not: “Location, location!” The latter component, which is the beneﬁt net of user charges, is manifested as uplifts in site values—not values of buildings, which are limited by construction costs, but values of space, because space has location, and therefore locational value, even if no buildings yet occupy it. Hence the cost-beneﬁt ratio of an infrastructure project, where the “cost” is also net of user charges, is simply the cost-uplift ratio. If the “tax” system claws back a certain fraction of every uplift in land values, any public infrastructure project whose cost-beneﬁt ratio does not exceed that fraction is self-funding or better than self-funding. The remaining (“after-tax”) portion of the uplift is a net windfall for the property owner. State “land tax” is suitable for clawing back some of the uplifts due to infrastructure—provided of course that the thresholds and marginal rates are left well alone, and are not adjusted every time property owners claim that they are suffering because their assets have risen in value! In truth, their “tax” bills do not increase unless their site values do, and their site values do not increase unless, in Financing the State of Victoria without Taxes 5 the judgment of the market, they are better off in spite of the “tax” implication. Indeed, they would be better off if the marginal “land tax” rates were higher, because this would cause more infrastructure projects to become self-funding, so that more projects would proceed, delivering more windfalls to property owners. For the same reason, ordinary home owners would be better off if the “land tax” base were broadened by including owner-occupied residential sites. In each case, if the new or higher rate were applied only to future increases in site values, there would be “no losers” in the transition. That said, other methods of implementation might make the beneﬁts for property owners more obvious, and might therefore be more politically acceptable. One such method is to give site owners the option of ceding partial interests in their sites to the State, in return for tax exemptions. Owners taking up this option would give the State an incentive to add value to their site(s). Existing State taxes other than “land tax” are woefully inefﬁcient at clawing back uplifts in site values due to infrastructure. Even development levies and the GAIC, which are ostensibly levied for the purpose of ﬁnancing infrastructure, and which are ostensibly justiﬁed by uplifts in property values do to rezoning and public provision of infrastructure, are not explicitly levied on or apportioned to the said uplifts. The situation would be much improved if all existing taxes on property transfers, including stamp duty, development levies and the GAIC, were replaced by a single transfer charge payable by the vendor and proportional to the real increase in the site value since acquisition,2 with a deduction for any expenses incurred by the vendor in contributing to the uplift (e.g. infrastructure provided by developers between developed residential lots, contributing to the location values of those lots). The modiﬁed transfer charge would not only facilitate and encourage public investment in infrastructure, but, unlike existing transfer taxes, would be guaranteed not to turn an otherwise proﬁtable purchase- resale cycle into a loss-maker. All this should appeal to property owners and their lobbyists and should therefore be “politically acceptable”. To avoid any charge of retrospectivity, vendors who acquired their properties before the change could be given the option of paying tax as if they had sold and bought back their properties on the last day before the change, so that the new charge would apply only to the uplift in the site value since the change. Public-Private Partnerships (PPPs) do not solve the infrastructure problem, because private own- ers, operators and ﬁnanciers have little or no ability to recover uplifts in land values. So they try to cover capital costs entirely from user charges, which are therefore too high, causing low patronage, which may prevent recovery of costs—unless taxpayers come to the rescue. Low patronage defeats the purpose of the service, while taxpayer-funded subsidies, guarantees or bailouts defeat the alleged purpose of private ﬁnance. 2.3 Competitiveness Residential and commercial tenants routinely pay 100% of the rental values of their sites to their landlords, and no landlord has ever suggested that this damages the State’s competitiveness! On the contrary, it obliges the tenants to use the sites productively in order to pay the rent. If only a fraction of the rental value of the site were payable to the landlord, the remaining fraction would be capitalized into a lease-transfer price, so that the occupant would pay the former fraction directly, and pay or 2 Contrary to superﬁcial appearances, this proposal would not amount to a shifting of the existing stamp duty from buyers to sellers. The obvious reason is that the seller will avoid tax on any subsequent purchase. But the fundamental reason is that any such “shifting” is done by the market. If a transfer charge is payable by the seller, the seller will want to add it to the price. If it is payable by the buyer, the buyer will want to subtract it from the price. In the end, the charge will be shared between the seller and buyer in inverse proportion to their bargaining power, regardless of who nominally “pays” it. But if the transfer charge depends on the increase in the site value since acquisition, it is convenient to make it payable by the seller simply because the seller already knows the value at the time of acquisition. 6 Prosper Australia forgo the latter fraction under the guise of interest on the transfer price. The division into “rent” and “interest” would have no effect on total operating costs, hence no effect on prices, hence no effect on competitiveness. Similarly, if a fraction of the rental value of a site is payable to the State as “land tax”, only the remaining fraction is capitalized into the “price” of the site and paid or forgone as interest on that price, and only that fraction is “bought” outright by the “owner” of the site. As long as the “tax” is levied on the “price” of the site, it cannot take the whole rental value, because if it did there would be no “latter fraction” to be converted into the “price”. Thus what is called “land tax” is in substance a shared-equity scheme, in which the private partner buys its share and pays rent on the public partner’s share, or a shared-tenancy scheme, in which the private owner buys less than the full use-right and compensates the public co-tenant for the remainder of the use-right. Thus “land tax” has no more effect on prices of goods and services, and is no more damaging to competitiveness, than any other system of shared interests—e.g. a partnership or joint-stock company. Complaints about “land tax” rates being “uncompetitive” are designed to obscure the fact that land is immobile and therefore not subject to tax competition. However heavily the land of Victoria is “taxed”, not one square metre of it will ﬂee across the border into NSW or South Australia. Potential buyers of land may take their money elsewhere, but in so doing they make the land cheaper for others; and what the others save on the land itself, they can spend on capital and labour to make the land productive. As the land stays put, someone must end up owning it, and the eventual owner must use it to generate sufﬁcient income to pay the “tax” on it, or ﬁnd a tenant whose “rent” will cover the tax, or ﬁnd a buyer. The need for tenants and buyers enhances their bargaining positions relative to landlords and sellers, making accommodation more affordable. So the landlords and sellers and their lobbyists campaign against “land tax”—by pretending that it makes accommodation less affordable! All other existing State taxes damage competitiveness. Payroll tax feeds into prices of goods and services produced in Victoria and consequently deters production in Victoria. Conveyancing stamp duty, by impeding reallocation of property needed for production, likewise raises prices of Victorian products. Development levies, not being strictly apportioned to unearned uplifts in site values, can have the same effect, although they are perhaps more applicable to residential sites than to sites used for production. Fire levies on building-insurance premiums amount to taxes on buildings, including buildings needed for production, and therefore impede production and raise prices. (Buildings, unlike land, are not quite “immobile” for tax purposes. While most buildings cannot be moved across State borders without prohibitive expense, private agents can respond to taxes on buildings by choosing to build in one State rather than another. In the long term, the effect of such decisions is much the same as if buildings themselves could ﬂee across State borders.) It is worth noting that ﬁre levies, like “land tax”, are recurrent charges paid by property owners. Hence it might be politically feasible to eliminate ﬁre levies in favour of increased “land tax” receipts. This would enhance competitiveness without offending property owners as a class, although there would be winners and losers within that class. 2.4 Sustainability The Committee will undoubtedly receive submissions alleging that sustainability requires limits on population growth. Be that as it may, the policies that inﬂuence Victoria’s population are determined mainly at the Federal level. As this submission is addressed to State legislators, it treats population growth as “given”. And for a “given” total population, sustainability is roughly synonymous with compactness of urban areas. New suburbs make new environmental footprints. The same is not true of increasing density in established suburbs. The redevelopment of a residential site to house a larger number of people is an opportunity to exploit new technology so as to reduce the environmental footprint per person. The Financing the State of Victoria without Taxes 7 overall footprint may not increase; and if it does, the increase will be less than if the same increase in population had been accommodated in a new suburb, because the latter option does not involve the replacement of existing environmentally unfriendly structures. More compact cities mean shorter commuting distances, hence shorter commuting times, hence fewer vehicles on the road at any one moment, hence less pollution (and fewer accidents and more family time). Population density (for a given total population) varies as the inverse square of the linear dimen- sions. But when commuting times are allowed for, the density (i.e. the number per unit area) of moving commuters is more like the simple reciprocal of the linear dimensions. So trafﬁc density does not rise in full proportion to population density. The picture improves further if we understand “trafﬁc” in terms of vehicles, especially powered vehicles: as the linear dimensions are reduced, more commuters can walk or cycle to their destinations, and it becomes feasible (even without the tax reforms proposed herein, but especially with them) to provide public transport within walking or cycling distance of a larger percentage of the population. As public transport carries more persons per vehicle than private transport and uses each vehicle for a larger fraction of the time, it has a smaller environmental footprint per passenger-km, compounding the beneﬁt of fewer passenger-km due to shorter commuting distances and the feasibility of walking and cycling. Encouraging compactness means encouraging high-intensity development of the best located, i.e. most valuable, sites. Further encouraging investment in public transport means clawing back uplifts in site values. Thus the requirements of sustainability are synonymous with those of property develop- ment and infrastructure, considered above. “Land tax” meets the requirements, as does any proposed arrangement whereby the State claims partial interests in site values. Other existing State taxes do not. 2.5 Job security, job creation In so far as existing taxes deter development and/or neglect infrastructure and/or damage competitive- ness, they endanger existing jobs and impede the creation of new jobs. As already noted, “land tax” and other shared-equity or shared-tenancy schemes are innocent on all counts, whereas other existing State taxes are guilty on all counts. But payroll tax is most worthy of opprobrium. Defenders of payroll tax claim that it is passed on in prices and is therefore equivalent to a consumption tax, like the GST. This argument conveniently considers only the downstream shifting of taxes. But when demand for inputs is elastic, taxes are also shifted upstream. When payroll tax and GST and shifted downstream, they indeed tax consumption. But when GST is shifted upstream, it taxes production, whereas when payroll tax is shifted upstream, it taxes employment—as all employers, broadcasters, barbers and taxi drivers know! To the extent that payroll tax feeds into prices, it adds to inﬂationary pressures and therefore raises the so-called natural rate of unemployment, which is the minimum unemployment rate that causes enough wage restraint to give stable inﬂation. The central bank adjusts interest rates so as to maintain unemployment at this “natural rate”. So payroll tax not only creates unemployment, but inﬂuences monetary policy so as to entrench unemployment. 2.6 Small businesses Small enterprises need affordable premises and therefore gain from a plentiful supply of commercial rental accommodation. The above remarks concerning property development [subsection 2.1] and the bargaining positions of tenants [subsection 2.3] are again applicable. Again “land tax” scores well, 8 Prosper Australia as does any proposed system of shared equity or shared tenancy in sites, while other State taxes score badly. It is sometimes said that payroll tax, because of its threshold, is the only tax that discriminates in favour of small business relative to big business. This is a polite way of saying that payroll tax is the only tax that deters small businesses from growing larger. Big business is undoubtedly pleased with this arrangement. The main deterrent to growth consists not in the tax itself, which applies only to the margin by which one’s payroll exceeds the threshold, but rather in the compliance cost, which imposes its full weight as soon as the threshold is reached, but amounts to a shrinking fraction of turnover as the business grows. Again, big business must be pleased. Of course, in view of the contribution of small business to the overall demand for labour, what is said under the “Small business” heading could almost as well be said under “Job security, job creation”. 2.7 Notes on “land tax” As “land tax” is in substance a shared-equity or shared-tenancy scheme [see subsection 2.3], it cannot fairly be described as a tax on land per se, or even land values per se. However, because the “tax unit” is not the site but rather the owner, and because the threshold and/or progressive rates apply to the aggregate value of sites held by the owner, “land tax” can fairly be described as a tax on aggregation. If the “tax unit” were the site and/or the rate were ﬂat with no threshold, there would be no tax penalty on aggregation. It can also be said that “land tax” is a tax on particular uses of land in that, for example, it applies to rented residential sites but not owner-occupied residential sites. Hence it induces sales of rental homes to owner-occupants and reduces the supply of homes to let, leading some commentators to claim that the selective application of land tax raises residential rents. This claim forgets that the same sales also reduce the demand for rental homes by turning renters into owner-occupants. But even if the claim were true, it only means that rents are higher than they would be if land tax were extended to owner-occupants. It does not mean that rents are higher than if there were no “land tax” at all; on the contrary, the “tax” makes it harder for owners to tolerate vacancies and therefore tends to reduce rents. A sales tax can be shifted onto the buyer because the tax is a cost of selling. But “land tax” cannot be shifted onto the tenant, because it is not a cost of letting. As the sales tax on an item is not payable until the item is sold, and as a delay in the sale has little effect on the return to the seller, the seller can easily hold out until someone offers a sufﬁcient price to cover the tax. In contrast, because the “land tax” on a vacant site is payable whether the site is let or not, and because the landlord is losing rent while the site remains unlet, it is neither so easy nor so proﬁtable to hold out for what is deemed to be “sufﬁcient” rent. This much is well understood by landlords and their lobbyists, who therefore campaign against “land tax” by claiming that they can do exactly what they cannot do: add the tax to the rent! To the extent that they “succeed” in this campaign, they sabotage the most efﬁcient existing mechanism by which the State can ﬁnance infrastructure projects that increase site values for the beneﬁt of owners. Thus they reap the just reward for their mendacity. 2.8 Notes on affordability Does the claimed uplift in site values due to infrastructure contradict the claimed improvement in affordability? No, because affordability is a matter of competition—speciﬁcally, competition among owners seeking tenants or buyers. Affordability is inversely related to rents or prices, but directly Financing the State of Victoria without Taxes 9 related to the spending power of prospective tenants or buyers, and to the amenity of the accommoda- tion. The balance between those competing inﬂuences is determined by competition. Holding charges on site values, including rents payable under any shared-tenancy contracts, facilitate the provision of infrastructure, which improves amenity and therefore raises property values. But the same holding charges also make owners more determined to attract tenants or buyers, improving affordability as deﬁned in terms of competition: the competition forces landlords and sellers to share some of their gains with tenants and buyers. In short, the increases in prices and rents due to infrastructure are more than offset by improved amenity, and do not compromise the claim of improved affordability. Improved affordability has implications for an earlier claim: if owners must share some of their gains with renters and buyers, then not all of the beneﬁt of infrastructure will show in site values as measured by market rents and prices, so that the observed “uplift” will be somewhat less than the beneﬁt. On the other hand, the removal of deadweight presumably increases multiplier effects and thereby improves the conversion of infrastructure into measurable amenity. Thus we need not conclude that improved affordability compromises the mechanism for ﬁnancing infrastructure. Even if it does, the effect is merely to lower the maximum cost-beneﬁt ratio of a self-funding project, or to raise the “clawback” needed to make any particular project self-funding; at worst, the difference is one of degree. 2.9 Notes on municipal rates Although this Inquiry is about “State” taxes, municipal rates and charges are relevant in that: • they are governed by State legislation; • their effects are within the Terms of Reference; and • they indirectly inﬂuence State revenue. CIV and NAV rates fall partly on values of buildings and other improvements, and are therefore hostile to development. To the extent that they do not fall on site values, they fail to encourage investment in infrastructure. These faults imply failure under all criteria in the Terms of Reference. By discouraging development and redevelopment, CIV and NAV rates reduce State revenue from stamp duties and payroll tax. By taxing values of buildings, CIV and NAV rates invite neglect of existing buildings, reducing the values of surrounding sites, hence State revenue from stamp duties, “land tax”, and any existing or proposed form of shared equity or tenancy in sites. If the State cannot afford to tolerate tax avoidance or tax evasion, neither can it afford to tolerate municipal rating schemes that erode the State revenue base. In contrast, SV rating resembles a “land tax” with a ﬂat rate, no threshold, and minimal exemp- tions, and therefore closely approximates a harmless shared-equity or shared-tenancy scheme (except that the marginal rate is not ﬁxed, but is calculated by working backwards from the total revenue required in the Council’s budget). We therefore submit that SV rating should be mandated, and that any municipal “service charges” that amount to de facto taxes on buildings (e.g., charges of so much per year per dwelling, or per some other unit whose presence is correlated with that of a dwelling) should be subject to a limit like that presently imposed on the “municipal charge” [Local Government Act, s.159]. The political pain caused by changes in the rating base can be minimized by explicitly allowing Councils to cap annual increases in bills. As the same caps would apply to increases caused by periodic revaluations, the overall volume of dissatisfaction with increases in bills would be less than under present arrangements, notwithstanding the changes in the rating base. 10 Prosper Australia Caps on increases in rates bills should be decided by Councils. They should not be imposed by the State, lest they unduly constrain the ability of Councils to fund necessary services (as allegedly happens in NSW). 2.10 Notes on debt For a government, as for a household, it is prudent to incur debt in order to acquire an asset that will reliably generate more than enough income or savings to retire the debt within the lifetime of the asset. If a government incurs debt in order to ﬁnance an infrastructure project, the ability to retire that debt within the service life of the infrastructure (or any desired shorter time) depends on the efﬁciency with which the revenue system captures uplifts in site values. The inefﬁciency of the present tax system in capturing such uplifts explains the neglect of infrastructure by successive governments. And the limited ability of private agents to capture such uplifts explains why PPPs have not solved the problem. 3 Constitutional threats to existing taxes Under s.90 of the Australian Constitution, only the Commonwealth may impose duties of excise. Victoria’s duties on registrations of new motor vehicles and sales of livestock clearly fall with the deﬁnition of “duties of excise” accepted by the High Court in Ha v. NSW (1997), and earlier cases.3 Unless the High Court does a volte-face,4 neither duty will survive a constitutional challenge. To the extent that payroll tax, conveyancing stamp duties, development levies and ﬁre levies feed into prices of goods, they arguably amount to duties of excise. The effect on prices of goods is especially clear in the case of payroll tax. Moreover, because payroll tax preferentially raises prices of goods produced within the State, it acts as a reverse tariff and is therefore likely to be ruled unconstitutional whether the High Court does a volte-face or not.5 Anyone carrying a criminal conviction for non-payment of an unconstitutional tax would seem to be entitled not only to have the conviction quashed, but also to have every related indictment, charge, arrest or warrant declared null and void for want of valid subject-matter, and to be substantially compensated. Presumably the Constitution trumps any statute of limitations, including any statute purporting to impose time-limits on criminal appeals. And obviously the State could not escape liability by reason of ignorance of the law! The more interesting question is whether public ofﬁcials who have collected unconstitutional taxes are guilty of criminal fraud, in which case they too would be unable to plead ignorance. Meanwhile, anyone who has paid an unconstitutional tax is free to sue for a refund, or to use the possibility of such a suit as leverage in any other dispute with the State. The Constitution is not to be triﬂed with. 3 P. Sampathy “Section 90 of the Constitution and Victorian Stamp Duty on Dealings in Goods”, Jour- nal of Australian Taxation, Vol. 4, no. 1 (2001), pp. 133–155; www.buseco.monash.edu.au/blt/jat/2001-issue1- sampathy.pdf . 4 Cf. G. R. Putland, “Wake up, Australia: Stamp duties on new cars are illegal” (blog post), Aug. 16, 2009; http://tribune.grputland.com/2009/08/wake-up-australia-stamp-duties-on-new.html . 5 Cf. G. R. Putland, “Payroll taxes levied by Australian States are probably unconstitutional” (blog post), Sep. 5, 2009; http://tribune.grputland.com/2009/09/payroll-taxes-levied-by-australian.html . Financing the State of Victoria without Taxes 11 4 Rent in lieu of tax The legislative embodiment of a voluntary shared-tenancy system in Victoria would be unusually simple. The essence of it would be contained in a single paragraph to the following effect: (1) Notwithstanding any other law made by this Parliament with respect to taxation, it shall be lawful for the SRO to enter into a contract with any entity, whereby the entity shall no longer pay taxes to the State provided that the entity grants to the State (a) a negotiated fraction of the tenancy in each assessable asset that the entity occupies, plus (b) the standard fraction of the tenancy in each assessable asset that the entity subsequently occupies. Obviously it is intended that the State will receive rent for its tenancy fractions (as compensation for not exercising the rights of a co-tenant), and that the rent will replace the forgone taxes. One deﬁnition can be given immediately: (2) For the purposes of paragraph (1), the entity shall be deemed to occupy any asset (or portion thereof) that the entity has a legal right to occupy or use and does not let or sublet. Other terms, including “standard fraction” are yet to be deﬁned. 5 Protecting the revenue Paradoxically, the strongest safeguard against net loss of State revenue through tax/rent exchanges is the mere fact that such exchanges would be voluntary. As the SRO would not be obliged to contract with any particular taxpayer, it would not need to accept any arrangement involving a risk of lost revenue. For this reason, the enabling legislation need not foresee every issue that might arise, but could leave most issues to be resolved in the contracts. And because the beneﬁts of experience gained from early contracts would appear in later contracts far sooner than they could appear in any legislative amendments, the enabling legislation need not include elaborate “anti-avoidance” measures of the sort commonly found in tax laws; if the SRO smells a rat, it simply won’t accept the deal. The only “anti-avoidance” provision needed in the legislation would a brief, broad statement such as the following: (3) In assessing any proposed contract under paragraph (1), the SRO shall give paramount consideration to the protection of State revenue, net of expenses incurred in the collection thereof. In particular, the SRO may: (a) require that the entity dispose of or fully utilize certain assets before the contract takes effect; (b) require that related entities be included in the contract or conclude sepa- rate contracts. But when any such contract is in force, the entity shall have the controlling interest in each affected tenancy, even if the entity’s numerical share of the tenancy is less than 50 percent. 12 Prosper Australia By judicious use of such terms and conditions, the SRO could prevent a taxpayer from (i) avoiding transfer taxes (if applicable) on imminent sales of assets, (ii) hoarding assets, failing to conduct tax- able business with them in order to negotiate low State tenancy fractions on exit from the system, and then selling the assets, or (iii) remaining in the tax system while conducting taxable business through a related entity that has opted out on favourable terms. For added security, clause (a) refers to “assets”, not “assessable assets”. But the “controlling interest” ensures that when the bargain is eventually struck, the former taxpayer’s freedom is not compromised. The “even if” is unlikely. 6 Deﬁnitions and explanatory notes 6.1 What is an “entity”? (4) In this Act, an entity is a natural person or other legal person. Note that an “entity” need not be domiciled in Victoria or even Australia and need not yet pay tax to Victoria. Thus, for example, a foreign corporation could sign a shared-tenancy contract in antici- pation of commencing business in Victoria, and become a contributor to State revenue without ever interacting with the tax system as we know it. 6.2 What are “taxes”? For present purposes, taxes include all payments to the Executive Branch except ﬁnes, proceeds of sales of goods and assets, and per-unit user charges. The standard distinction between taxes and charges, namely that charges are requited while taxes are not, is generally followed. For example, royalties for ﬁshing, logging, mining or drilling, whether “speciﬁc” (apportioned to quantity) or ad valorem (apportioned to value), are per-unit user charges (being payments for depletion of resources owned by the people); but annual “fees” for mining and logging licenses are taxes in so far as they exceed the State’s associated costs, as are annual “fees” for vehicle registrations. Water/gas/electricity consumption tariffs are per-unit user charges; but annual fees for “connection” to such services, if payable to a government, are taxes (because any expense incurred by the provider of the “connection” is one-off, not annual). A parking fee levied on a motorist for parking on a public street for a limited time is a per-unit user charge; but a parking-space levy paid by a private property owner who provides parking on his/her own property is a tax. These examples have been chosen because they are on the borderline; most cases are more obvious. The prevalence of ofﬁcial euphemism is also helpful: if it’s ofﬁcially called a tax, it’s probably a tax. The last remark applies to “land tax”, not because it is a true tax, but rather because we envisage that “land tax” would be replaced by any voluntary shared-tenancy arrangement. But some apparent “user charges” are also worthy of replacement, and could be described as taxes on the ground that they exceed reasonable costs (as we shall see). Because of cases like these, perhaps the safest way to deﬁne “taxes” in the enabling legislation would be to list them by name: (5) In this Act, taxes include: (a) . . . The laws imposing the taxes could also be cited, if needed for clarity. That would deal with current taxes. To allay any fear that the contracts will be undermined by new taxes, the list would probably need to end with a catch-all item like: Financing the State of Victoria without Taxes 13 (..) other sources of State revenue subsequently enacted by this Parliament (excluding ﬁnes, proceeds of sales of goods and assets, and per-unit charges on users of services). 6.3 Why retain per-unit user charges? Service charges can be defended as a means of rationing the use of services. Economic theory tells us that the use of a service will be socially optimal if it is priced at the marginal cost, i.e. the cost of providing the next unit of service—not to be confused with the ﬁxed cost, which is incurred regardless of utilization, or the average cost, which is the total cost (including the ﬁxed cost) divided by the number of units provided. At present, some apparent user charges, notably including road/bridge tolls and public transport fares, are substantially above marginal costs. Hence it is arguable that such “charges” should be treated as taxes and consequently waived for entities that accept shared-tenancy contracts. These entities would contribute to the cost of infrastructure through the partial rents that they pay on sites— provided, of course, that sites are “assessable” assets. 6.4 Who is deemed to “pay” a tax? For present purposes, to “pay” a tax is to remit it to the SRO, not merely to pay a price inﬂated by tax remitted by the vendor or someone further up the supply chain. To avoid doubt, the enabling legislation could say something like: (6) For each type of tax, for the purposes of paragraph (1), the party deemed to pay the tax shall be the party responsible for the ﬁnal settlement of the account with the SRO. Or the parties that “pay” could be listed along with the taxes. From paragraphs (5) and (6), taxpayers can work out what taxes they would avoid by accepting shared-tenancy contracts. For each tax they would avoid not only the tax itself but also the associated compliance cost, which is the cost (in cash or kind) of calculating tax obligations and maintaining the necessary records, and the associated deadweight cost, which is the value of opportunities lost because otherwise viable transactions or projects are rendered unviable by the tax and/or its compli- ance cost (although the apportionment of costs between entities is more problematic for deadweight costs than for compliance costs). 6.5 What is an “assessable asset”? For a typical individual taxpayer, the only assessable asset will be the site of one’s residence. For a typical small enterprise, the only assessable asset will be the site of one’s business premises. Having answered the question for most taxpayers, let us now explain the underlying principles and give further examples. If every taxpayer under Victorian jurisdiction accepts a shared-tenancy contract, the State will thereafter derive revenue only from shared rents of assessable assets. If those assets do not subse- quently appreciate at least in proportion to the State’s revenue requirements, then the State will have to choose between cutting services (politically difﬁcult, if not unconscionable), breaching the con- tracts (politically suicidal, if not unconstitutional), and inﬂating user charges above marginal costs (economically inefﬁcient). If only some taxpayers accept contracts, any shortfall in revenue from shared tenancies will impose an unfair burden on the remaining taxpayers, who, if they then opt out of the tax system by accepting contracts, will do so on less favourable terms than their predecessors. 14 Prosper Australia If such adverse outcomes are to be avoided, the assets classiﬁed as “assessable” must be such that they appreciate in response to economic growth. That requirement is met by the following deﬁnition: (7) In this Act, an assessable asset is an asset which is inside Victoria or otherwise un- der its jurisdiction, and which no entity can replicate, eliminate, or remove from that jurisdiction. If assets outside Victoria were assessable, that would create “double taxation” issues when other states inevitably followed Victoria’s lead. If “assessable” assets could be destroyed or otherwise eliminated, they might not appreciate collectively, and entities under contracts would be able to avoid State rent payments by destroying the assets (or failing to maintain or replace them). If “assessable” assets could be freely replicated, they would fail to appreciate individually, because any such appreciation would induce additional production, which in turn would devalue the existing stock. Worse, production by entities that are still in the tax system would devalue assets held by entities under contracts, causing a loss of State revenue. But if “assessable” assets cannot be freely replicated, the increase in effective demand for such assets (caused by economic growth) cannot induce an increase in supply, but is reﬂected in increasing rents and prices. It is clear that under the above deﬁnition, assessable assets exclude buildings, plant and equipment, and goods and chattels. The most obvious type of asset that private entities can neither replicate nor eliminate is space, which is divided into sites, which are deﬁned in terms of location and therefore cannot be moved out of Victoria’s jurisdiction, which itself is deﬁned in terms of location. By conferring additional rights on the use of space, governments can add value to sites or effectively create sites (as when building- height limits are increased); but private entities cannot do these things. Growth of the local economy can also add value to sites; but a single private entity (unless it is freakishly large) cannot signiﬁcantly drive that growth. Moreover, sites are especially suitable for shared-tenancy contracts because every taxable entity must occupy a site. We may therefore consider sites as the archetypal, quintessential “assessable” assets, and all other assessable assets as site-like. Licenses satisfy the deﬁnition of “assessable” provided that they are strictly limited in supply and that their use is conﬁned to Victoria. Taxi licenses (also known as plates) satisfy this deﬁnition. Ordinary drivers’ licences do not, because they are not limited in supply. Other licences that must be or can be limited in supply include gambling licenses, water rights, ﬁshing/logging/mining/drilling rights, easements and rights of way, and seaport time slots. A monopoly is the extreme case of a limit on the number of licenses: just one license. Not all monopolies are created by governments. A networked service is by nature a monopoly—a natural monopoly—because any competitor wanting to sign up its ﬁrst customer must either replicate the network (for one customer?) or connect to the existing network. Even if the existing network was initially created by one private entity, it cannot realistically be replicated by another; and because such a network has a spatial dimension, its “creation” requires other assessable assets such as sites, easements, and rights of way. To ensure that all assets that need to be “assessable” are indeed assessed, the enabling legislation could say something like: (8) At the time of commencement of this Act, for the purposes of paragraph (7), assessable assets shall include, without limitation: . . . Then would follow a list. The phrases “At the time of commencement. . . ” and “without limitation” leave open the possibility that the list may grow in response to technological or constitutional change. A late addition to the list would not cause any sudden change in rent payments, because no rent would Financing the State of Victoria without Taxes 15 be payable on a newly assessable asset until the next transfer of tenancy [see paragraph (1), especially clause (b)]. Neither would it cause a sudden change in resale values, because the reclassiﬁcation of an asset type would be anticipated and “priced in” long before implicit assessability became explicit. 6.6 What is the “standard” fraction? Because the standard fraction would apply only to tenancies commencing after the occupants opted out of the tax system, it would not be critical in taxpayers’ decisions to opt out or for short-term adequacy of revenue. But, to answer the question, the enabling legislation would say something to the effect: (9) The standard fraction shall be X percent, unless a lower percentage is ﬁxed by reg- ulation, in which case change in such regulation shall be subject to disallowance by Parliament. In practice, the standard fractions would be initially set at X percent, but would tend to fall in the long term because the values of assessable assets would tend to grow faster than revenue requirements. Therefore the limit X would tend to become entrenched: in theory it could be increased by amend- ing the legislation, but in practice it would take an extreme emergency to make any such increase politically acceptable. For these reasons, X would affect adequacy of revenue in the medium term rather than the short or long term. To be safe, X could be set as the total tax currently paid to the SRO by occupants of assessable assets, expressed as a percentage of the total rental value of the assets. The outline of the enabling legislation (indented and italicized) is now complete. The Committee may compare its complexity with that of any existing piece of tax legislation. 7 Positive effect on asset values 7.1 All taxes come from gross economic rent. Because assessable assets cannot be produced by private agents, the returns on such assets cannot serve as incentives to produce the assets; that is, the returns are economic rent. From the viewpoint of the taxpayer, the supply of assessable assets in Victoria is ﬁxed. For ex- ample, the overall supply of land is ﬁxed, as is the supply of land legally usable for any particular purpose, or within acceptable distance of any particular services, infrastructure, or markets. Yet ac- cess to some sort of assessable asset is essential to life and livelihood. For an wage-earner per se, the one essential assessable asset is a residential site. For a retailer per se, it’s a commercial site. For a taxi driver per se, it’s a plate. But for every economic agent, securing access to some part of that limited pool of assessable assets is a prerequisite for economic participation. Therefore rents and prices of assessable assets are bid upward until they absorb the economy’s capacity to pay. As all taxes are deductions from that capacity, all taxes are ultimately borne by the owners of assessable assets as deductions from their gross (pre-tax) economic rents. It follows that if all taxes were levied directly on assessable assets, the owners would be no worse off; that is, their net (after-tax) economic rents would be undiminished. Hence, in a rational market, the transfer prices of the assets, i.e. the discounted present values of their anticipated net economic rents, would also be undiminished. 16 Prosper Australia 7.2 All deadweight costs come from gross economic rent. The margin by which taxes reduce the capacity to pay for assessable assets, and hence reduce the values of the assets, includes not only the taxes themselves but also their deadweight costs. Thus we may think of deadweight as the margin by which asset owners are overcharged. Unlike taxes, rent shares payable by occupants would not deter any productive activities carried out in the course of tenancy, but rather would make such activities all the more necessary as means of paying the rent. Thus the negative effect of deadweight on asset values would be eliminated; the owners would no longer be overcharged. In practice, in the negotiation of each shared-tenancy contract, the saving in deadweight costs plus compliance costs would be a net beneﬁt to be divided between the taxpayer and the State, making the contract mutually beneﬁcial. For the purpose of computing the economy-wide effects of these savings, the per-contract savings in compliance costs are additive only in so far as they are incurred in kind, because a cost incurred in cash is a beneﬁt to the payee; but the perceived savings in deadweight costs are better than additive, because individual traders suffer deadweight not only because of their own tax liabilities but also because of others’ liabilities. 8 Speciﬁc implementation issues 8.1 Coexistence with the tax system Entities under shared-tenancy contracts would no longer remit indirect taxes (including payroll tax), but would still bear any indirect taxes hidden in prices that they pay—although those hidden taxes would be reduced as other entities opted out of the tax system and consequently stopped remitting indirect taxes. If an entity ceases to pay a certain State tax, it ceases to be eligible for deductions against the associated tax base and for offsets against the tax payable. For each tax, that outcome is probably guaranteed by existing legislation. If an existing tax has exemptions for certain entities, the governing legislation or regulations or case law will contain any necessary rules concerning transactions between a taxed entity and an exempt entity. Again, the existing law will probably imply that the same rules apply if the “exempt” entity is exempt by reason of having opted out of the tax system. 8.2 Householders, charities, etc. A householder who opted out of the tax system would enjoy (e.g.) discounted car registration and free use of public transport and tollways, but would cede a partial tenancy in the home site. The rent required to “pay out” that partial tenancy would increase with the value of the site. In case this increase is not matched by an adequate increase in income, the householder, if an owner, could be allowed to defer any increment in the rent payable for the State’s co-tenancy until the property is sold or otherwise transferred. Renters, of course, would not have this option; but neither do they have it in respect of their normal rent, which is a much bigger problem. Similar concessions are possible in respect of sites used for educational, charitable, or religious purposes. Financing the State of Victoria without Taxes 17 8.3 Severance “taxes”, resource rent taxes As noted above, speciﬁc or ad-valorem charges for ﬁshing, logging, mining or drilling, although sometimes misnamed “severance taxes”, are properly called royalties rather than taxes. (Indeed, if they were taxes they would be excises and therefore forbidden to the States!) Not being taxes, they are implicitly outside the scope of shared-tenancy contracts and would be retained under the new system. But if any “resource rent taxes” or “excess proﬁt taxes” on the proceeds of mining or drilling were to be devolved to the States in consequence of the Henry review, such taxes would be eliminated under shared-tenancy contracts, for three reasons. First, they are ofﬁcially called taxes. Second, they add to compliance costs, the elimination of which is a major goal of shared-tenancy contracts. Third, they are variants of income tax, which is normally regarded as a true tax, and which is applicable even if the income in question happens to come from land or other natural resources. 8.4 Assessing the rent Values of sites are routinely assessed for the purpose of municipal rating. Licenses, if tradeable or rentable, can be valued by recording market transactions. Taxi plates, for instance, are both tradeable and rentable—or if not are easily made so by some judicious deregulation. If a certain license is already rented from the State under a competitive bidding system, the State is already collecting 100% of the rent. Does that mean an additional rent fraction can be negotiated under a shared-tenancy arrangement? Yes, because an entity that does not pay tax on the proceeds of using the license will be able to bid more for the license itself, and will need to do so in order to beat other bidders in the same situation. If “all taxes come from gross economic rent,” the rent paid by taxpayers is net, not gross. In some cases it might be convenient for an asset owner to pay shared-tenancy rent based on its own valuation of the asset, with the proviso that the same valuation shall apply if the asset is compulsorily acquired—this proviso being an obvious deterrent to undervaluation. Prospectuses and reports to shareholders are further sources of valuations in which owners or their agents estimate values of assets and have an incentive not to understate them. Details not explained here are nevertheless within the competence of professional valuers and, in disputed cases, the courts. 8.5 Tax base “competition” A voluntary shared-tenancy scheme in lieu of State taxes could coexist with a similar scheme in lieu of Federal taxes, involving the same assets. While each government’s tenancy share by itself would cut into the market rent that entities would bid for a particular asset, the corresponding tax exemption by itself would increase the rent that entities would bid, and the two effects would roughly cancel out: “all taxes come from gross economic rent.” The effects on the capitalized values (sale prices) of the assets would similarly cancel out: while the fair price of a site-like asset is the capitalization of its net rental value, it makes little difference whether that net rental value is “net” of tax or “net” of rent payable to a public co-tenant. 8.6 Additional taxes for times of emergency? If “all taxes come from gross economic rent,” then gross economic rent is the whole revenue base, and any attempt to extend the base to the rewards of labour or capital—let alone more nebulous concepts such as “income” or “consumption” or “property”, each of which includes the returns to more than one factor of production—is futile. 18 Prosper Australia It follows that when governments increase taxation in times of “emergency”, they are effectively expropriating additional fractions of the values of site-like assets, whether they admit it or not. But by admitting it, they can avoid deadweight costs and compliance costs, both of which impair the capacity to deal with the perceived emergency. 9 Advantages for particular interest groups 9.1 Accountants, tax lawyers, realtors, conveyancers A population contemplating optional rearrangements of its tax affairs would obviously generate much business for the professionals who facilitate such rearrangements or give advice thereon. Much of the demand would come from property owners, who would want to support the new system in order to proﬁt from increased expenditure on infrastructure, but who would then need to rationalize their holdings, either generating income from each property or selling it to someone who will. This would be a bonanza for the property-transaction and property-management industries. 9.2 Enterprises Payroll tax is a marginal cost and therefore must be recovered through prices if an enterprise is to grow. This obviously impedes growth. By accepting a shared-tenancy contract, an enterprise could replace this marginal cost with a ﬁxed cost (rent) and thereafter grow without the need to recover extra tax through prices. This, together with the elimination of compliance costs, would be a clear advantage in the contest for market share. 9.3 States, nations; “historical inevitability” The advantage for enterprises indicates that if a state offers shared-tenancy contracts in lieu of taxa- tion, the take-up of that offer will be rapid. Because shared-tenancy rents would not feed into prices, including prices of exports and of products that compete with imports, a state with a high percentage of entities under shared-tenancy contracts would have a competitive advantage over states with only conventional tax systems. The policy of allowing shared tenancy in lieu of taxation would therefore spread rapidly from state to state, both intranationally and internationally. 10 Recessions and ﬁnancial crises 10.1 Prevention It is well known that the “Global Financial Crisis” began with the bursting of the U.S. housing bubble. Of course a so-called “housing bubble” or “property bubble” is actually a land bubble. Buildings, whose values are limited by construction costs and depreciation, are not worth speculating on. But sites appreciate in line with capacity to pay; and in a rising market, rational expectations easily give way to belief in the greater fool, until the market runs out of greater fools. It is not so well known that in about 80% of the countries that subsequently entered recession, the onset of recession was preceded by a collapse in the domestic property market.6 6 G. R. Putland, “From the subprime to the terrigenous: Recession begins at home”, LVRG Blog, Jun. 1, 2009; http://blog.lvrg.org.au/2009/06/from-subprime-to-terrigenous-recession.html . (An update to this item is in preparation.) Financing the State of Victoria without Taxes 19 The recessions of the mid ’70s, early ’80s and early ’90s in the UK and Australia followed the same pattern, as did the so-called Asian Financial Crisis of 1997, and every major U.S. recession since 1800, including the Great Depression. By late 2008 it was clear that Australia’s housing bubble had burst. The Federal Government, with its First Home Owners’ Boost, created a new bubble at the bottom of the market in a desperate attempt to avoid a full-scale collapse. The attempt will fail as soon as the Boost is withdrawn. And of course the Boost did nothing for the commercial/industrial property market, which peaked at about the same time as the residential market. So we see that preventing recessions is largely a matter of preventing boom-bust cycles in the land market. Wild swings in land prices occur because of contradictory price signals. When a bubble is inﬂating, high prices by themselves deter buyers; but rising prices attract buyers by (seemingly) promising “capital gains”, negating the correction that should be provided by high prices. After the bubble bursts, low prices by themselves attract buyers, but falling prices deter buyers by threatening “capital losses”, negating the correction that should be provided by low prices. So the market over- shoots in both directions. To prevent this, one must attenuate or counteract the signal sent by the rate of change of prices. The obvious solution is a holding charge on values of sites: rising prices mean rising holding costs, which deter purchases and encourage sales, while falling prices mean falling holding costs, which encourage purchases and deter sales. “Land tax” satisﬁes this prescription. Rents payable under shared-tenancy agreements would also do the job. In so far as they would be payable by owner- occupants and owners without tenants, they would feed back negatively on prices; and in so far as they would be payable by tenants, they would feed back negatively on market rents, hence prices. 10.2 Recovery If the bubble has already burst, reducing the deadweight cost of the tax system will reduce the severity of the ensuing recession or, if the recession has already started, accelerate recovery. Allowing people to opt out of the tax system altogether, as proposed here, is a politically safe way to reduce deadweight. The ensuing removal of taxes from the prices of exports and import replacements would further assist recovery. 11 Conclusion We have noted in passing that investment in infrastructure would be greatly facilitated if all existing taxes on property transfers (including stamp duty, development levies and the GAIC) were replaced by a single transfer charge payable by the vendor and proportional to the real increase in the site value since acquisition. This change would yield clear economic and political beneﬁts for comparatively little political risk. But greater beneﬁts could be obtained for even less political risk by allowing each Victorian taxpayer to opt out of the tax system altogether, on the condition that the State shall be a co-tenant of each site-like asset occupied or used by the former taxpayer. The take-up of this option would be rapid as both taxpayers and the State would be keen to eliminate deadweight costs. The remaining deadweight costs would fall in synchronism with the number of entities remaining in the old tax system. Thereafter, the State would ﬁnance its expenditure not from taxation, but from rent shares, which the State would effectively have purchased by giving up its taxing powers.
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